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Resolving an Investment Disagreement
Two friends, Maya and Liam, are evaluating a guaranteed investment that will pay $10,000 in 10 years. They are using the present value table below.
Present Value of a Future $1 Payment
| Years in Future | 4% Discount Rate | 6% Discount Rate | 8% Discount Rate |
|---|---|---|---|
| 5 | $0.822 | $0.747 | $0.681 |
| 10 | $0.676 | $0.558 | $0.463 |
| 15 | $0.555 | $0.417 | $0.315 |
Maya argues, "Using a 4% discount rate gives the investment a present value of $6,760, while an 8% rate gives it a value of only $4,630. Clearly, we should use the 4% rate because it makes the investment look more valuable."
Liam disagrees, stating, "You can't just choose the discount rate that gives the highest present value. The discount rate should reflect our actual opportunity cost of capital or the risk involved."
Whose reasoning is more correct from a financial perspective? Explain the flaw in the other person's argument.
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CORE Econ
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Introduction to Microeconomics Course
The Economy 2.0 Microeconomics @ CORE Econ
Evaluation in Bloom's Taxonomy
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Present Value of a Future $1 Payment
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Present Value of a Future $1 Payment
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Present Value of a Future $1 Payment
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Present Value of a Future $1 Payment
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